Stocks lower ahead of US 'fiscal cliff' talks

European and U.S. shares traded lower on Friday on waning hopes that U.S. President Barack Obama and key lawmakers would manage to reach an 11th-hour budget compromise.

U.S. politicians have until Monday night to hammer out an agreement before the U.S. runs over the "fiscal cliff" - hundreds of billions of dollars in tax increases and deep cuts to government spending that automatically kick in on Jan. 1. Such a drastic measure could throw the U.S. into another recession, economists have warned.

Spain's benchmark IBEX 35 dropped as much as 1.81 percent, dragged down by troubled bank Bankia which was trading down 27 percent at (EURO)0.40.

Fueling the decline, Spain's prime minister Mariano Rajoy said that he expected the country's economy to continue to be in recession until the second half of next year.

Wall Street also fell on fears of the "fiscal cliff" with the Dow Jones industrial average was down 0.5 percent at 13,031, while S&P 500 was lower by 0.4 percent at 1,411.

"Equities look set to exit 2012 with a whimper, after politicians in Washington said that a deal to resolve the budget issues is now very unlikely before the deadline," Chris Weafer of Moscow-based Sberbank CIB investment bank said in a note.

Congressional leaders and President Barack Obama are expected to meet later Friday at the White House for last-minute talks. Obama and congressional Democrats want a deal that would let tax rates rise for the wealthiest taxpayers, a measure opposed by Republicans.

Failure to avoid the fiscal cliff doesn't necessarily mean tax increases and spending cuts would become permanent, since the new Congress could pass legislation to cancel them retroactively after it begins its work next year.

"Even if it falls into the fiscal cliff, you will only reduce the deficit by about $100 billion," said Francis Lun, managing director of Lyncean Holdings in Hong Kong, referring to the U.S. economy. "In Chinese terms, it's like trying to douse a fire with a cup of water. They should do what Europe has done and try to impose austerity."

In Asia, markets saw another day of boisterous trading.

Tokyo's Nikkei 225 index rose 0.7 percent to 10,395.18, its highest level since March 10, 2011, the day that an earthquake and tsunami pummeled Japan's northeastern coast.

Investors have been cheering newly named Japanese Prime Minister Shinzo Abe and his calls for more public spending to reinvigorate the economy. He also wants the Bank of Japan to raise its inflation target from 1 to 2 percent to drag the country out of two decades of deflation, or steadily declining prices that have deadened economic activity.